LECTURE 1

INTRODUCTION TO PUBLIC FINANCE

Objectives

At the end of this lecture you should be able to:

 Explain the role of public finance

 Discuss the role of government in economic development
 Identify and discuss various sources of government revenues
 Identify and explain the reasons for government intervention in the market
 Explain types of externalities

Content

 Meaning and role of public finance

 The role of government in economic development
 Sources of government revenues
 Government intervention in the market
 Externalities

1.1 Public finance

Is the branch of economics which analyses on how government raise fund and spend and the
laws and regulation which guide the expenditure through monetary and fiscal policy or

Is the branch of economics which analyses the effects of central government and local authority
income and expenditure activities on the economic situation of individual and firms on the
economy as a whole i.e is a study of the economics of the public sector which involves its
revenue and expenditure or

Public finance is the study of the role of the government in the economy. It is the branch of
economics which assesses the government revenue and government expenditure of the public
authorities and the adjustment of one or the other to achieve desirable effects and avoid
undesirable ones.

Public finance include four components namely government revenue, government expenditure,
government budget and public debts.

For many economists the term ‘public finance’ is now synonymous with ‘public economics’. The
study of the political economy of governments and their agencies – sometimes labelled ‘Public
Choice’ – is also often regarded as part of ‘public finance’. A key focus of the economics of
public finance is the impact of governments on the behaviour of the private sector – whether as
individuals, taxpayers, consumers, voters, producers (firms) or investors. This includes both
‘positive’ economic analysis and evidence (the ‘what is?’ questions) and ‘normative’ economic
analysis (the ‘what should be?’ questions).

However ‘public finance’ also covers wider issues beyond economics including Public Finance
Management, and Accounting. Especially within the study of taxation, the disciplines of
Accounting and Law are just as prominent, if not more so, than Economics. Public finance or tax
accounting covers issues such as the relationship between accounting standards and the
determination of taxable income, accounting practices in the public sector while issues of tax law
are ubiquitous to any discussion of tax settings and policy.

1.1.2 Role of public finance.

The purview of public finance is considered to be threefold: governmental effects on (1) efficient
allocation of resources, (2) distribution of income, and (3) macroeconomic stabilization.

1. Efficient allocation of resources

Collection of sufficient resources from the economy in an appropriate manner along with
allocating and use of these resources efficiently and effectively are the essential
components and role of a public finance basically deals with all aspects of resource
mobilization and expenditure management in government. Just as managing finances is a
critical function of management in any organization, similarly public finance
management is an essential part of the governance process.

While allocating the scarce resource it includes resource mobilization, prioritization of

programmes, the budgetary process, efficient management of resources and exercising
controls. Rising aspirations of people are placing more demands on financial resources.
At the same time, the emphasis of the citizenry is on value for money, thus making public
finance management increasingly vital.

2. Distribution of income

Public finance is closely connected to issues of income distribution and social equity.
Governments can reallocate income through transfer payments, Some forms of
government expenditure are specifically intended to transfer income from some groups to
others. For example, governments sometimes transfer income to people that have
suffered a loss due to natural disaster. Likewise, public pension programs transfer wealth
from the young to the old. Other forms of government expenditure which represent
purchases of goods and services also have the effect of changing the income distribution.
For example, engaging in a war may transfer wealth to certain sectors of society. Public
education transfers wealth to families with children in these schools. Public road
construction transfers wealth from people that do not use the roads to those people that do
(and to those that build the roads).
 3. Macroeconomic stabilization

The government to perform this function well or to attain this goals has design to use
fiscal and monetary policy. For economy to be stable means that there is high
employments, price stability soundness of foreign accounts and an acceptable rate of
growth, no inflation also no deflation. The economy stablelization do not come about
automatically in a market economy but requires a public policy guidance without it
economy tends to be subject to substantial fluctuations and it may suffer firm sustained
periods of unemployment or / and inflation.

4. Income redistribution

1.2 The role of governments in the economic development

An alternative three-way classification of the role of government in the economy was proposed
by Richard Musgrave, who suggested that government activities could usefully be thought of as
having effects on: “(1) efficient allocation of resources, (2) distribution of income, and (3)
macroeconomic stabilization.” And these have already explained and elaborated in the role of
public finance. Other roles is as follows:

1. To Correct Market failure occurs when private markets do not allocate goods or services
efficiently. The existence of market failure provides an efficiency-based rationale for
collective or governmental provision of goods and services. Externalities, public goods,
informational advantages, strong economies of scale, and network effects can cause market
failures. Public provision via a government or a voluntary association, however, is subject to
other inefficiencies, termed "government failure."
2. Protective functions
3. Administrative functions
4. Social functions and
5. Development functions

1.3 sources of government revenue

Government revenue refer to the income generated by the government through various income
sources inside and outside the particular government, As to any other person one will be eager to know
where government earn money to finance its activity as well as expenditure of the government.

The government of Tanzania has focused itself on raising revenue from a limited
number of sources. Taxation on drinks, fuel, cigarettes & tobacco products, Value
Added Tax and Pay as You Earn (PAYE) have been the major focus of taxes. The
current general consensus amongst the citizens is that these sectors are already
overtaxed and government cannot impose any further taxes in these areas
without aggravating the already rising costs of living and sinking the population
further into poverty. The emerging question, therefore, is from where else can
government raise more money

The following are the source of revenue of various government including united republic of Tanzania
(URT) :-

1.3.1 TAX REVENUE

a. Taxation is a compulsory levy imposed by the government whereby no direct
benefit citizen will receive from the government ,The levy is usually payable by
citizen at different rate depending on the nature of economic activity conducted by an
individual or firm the obtained amount is the revenue for the government and is used
to meet various expenditure causing taxation to be the first source of government
revenue.

Taxation includes both direct tax and indirect tax i.e PAYE, VAT, Corporate tax, customs and
excise duties.

1.3.2 NON TAX REVENUE

a. Fees These are payment made by users of public services on government cost sharing in health and
education, That is to say the payment made by user of public services i.e health and education is not the
actual cost that they were required to pay rather than contribution on cost already payable government.

b. Fines and penalties Refer to the penalties imposed by government against law breaches,i.e any
person or firm which ha been proved guilt by law must be exposed to specific fine as the compensation
for the destruction made by a person or firm and the collected amount being the revenue for the
government
c. Grants, Refer to non-payable money provided by the government to another government with the
aim of helping such government either to improve or to start a project which are of great importance.to
the society of such government.
d. Foreign investments Sometime government may decide to invest beyond its boundary provided
there is a proof for sustainable and profitable cash flow, the obtained amount after operation being the
revenue for particular government.

e. borrowing both internal and external borrowing

f. Aid this is the same as grants but the difference is aid is given with condition.

g. Ceased goods or forfeitures

h. Dividends

i. Licenses and permissions

j. selling of government assets

1.3.1 Local Governments sources of revenue.

local government revenues is an important dimension in the design of a sound

system of local revenues. There is consensus among public economists that a
(local) revenue sources should follow the ability-to-pay principle in order for
the revenue to be considered fair, meaning that taxpayers that are better able to
afford the tax should pay more. However, this does not necessarily mean that
(local) revenue sources should be progressive. In fact, the public finance
literature explicitly suggests that it generally not the role of local governments
to finance redistributive activities. Nonetheless, it is important to take into
account the concept of vertical equity in the assessment of the system of local
government revenues. The aggregate local government revenue collection data
(reported by local governments) is unable to reveal the incidence of local
taxes across taxpayers. In response, a Poverty and Social Impact Analyses
(PSIA) study was commissioned by the World Bank (2005)

Main Sources of Municipal Revenue( local government)

In the United Republic of Tanzania, the sources of finance and the manner in which it is to be
accounted for are well defined under the Local Government Finance Act of 1982. Equally well
defined is the entire budgeting process machinery within every city, municipal, town and district
authority.

The main sources of local government revenue are provided for in sections 6-10 of the Local
Government Finance Act of 1982. In all, there are over 56 sources of revenue for local
government in the United Republic of Tanzania, with grants from the central government being
the 57th source

Local Government Act defines the duties, functions and responsibilities of the local authorities.
It also stipulates the sources of their finances by making approvals for each authority depending
on sources identified (from the wider range of sources they have as options). Revenue finance is
raised to meet the local authorities' recurrent expenditures while capital finances are raised to
carry out capital works, such as roads, water and sewerage expansion, housing, street lighting
etc.

Local authorities have the following sources open to them, for purposes of raising revenue
finance:

a. Rates
- Land rates on property owned by individuals, companies or the government, including
parastatals

- Rates on buildings (i.e. developed property)

b. Fees and Charges, the key ones being:

- Premises licences;
- Occupational licences;
- Services or facilities - ambulances, survey fees, etc.;
- Goods or documents supplied - water sewerage, building approvals, transfer fees;
c. Commercial activities, including returns from own investments and rental income:

d. Cess and royalties;

e. Return on investments - investments in companies they do not explicitly control;

f. Grants from the government, donations and also transfers from other arms of the government;
and

g. With the approval of the Minister, short-term borrowing (through bank drafts) to meet
immediate needs and long-term borrowing to undertake investments and/or undertake capital
works.

• Local authorities may finance capital programmes through:

• Internal resources - Money set aside from the budget to pay for projects, commonly known as
revenue contribution to capital;

• Local Government Loans Authority - a separate statutory body performing its activities under
the supervision of the Ministry of Local Government, with a responsibility for lending funds
from the central government to local authorities;

• Domestic housing finance institutions - local authorities do rely on the National Housing
Corporation (NHC), a government parastatal, and Housing Finance Company of Kenya (HFCK),
a private company in which the government has some interest, to provide housing loans;

• Domestic banks - Local authorities normally rely on local banks and financial institutions to
provide short-term finances (mostly bridging) to finance projects;

• Stock issues - The local authorities are empowered to issue stocks and bonds to raise revenue
for their own operations. Nairobi is the only local authority that has in the past been able to raise
capital by use of this option;

• Capital grants - Grants are also provided to some local authorities by donor agencies and
specialized agencies for specific purposes; and
• External loans - Local authorities do borrow from international agencies, such as the World
Bank, to undertake big capital projects, such as water and sewerage, road works, housing etc.

Table 1. Sources of local government revenue in the United Republic of Tanzania besides
grants from the central government

A. TAXES

1. Development Levy
2. Business Licences
3. Property Tax
4. Industrial Cess
5. Road Licence fees
6. Petrol Levy
7. Hotel Levy
8. Cesspit emptying fees
9. Taxi, pickup and lorry fees
10. Advertising Fee (billboards)
11. Market dues/stalls rent
12. Building Plans fees
13. School fees, English medium
14. Intoxicating Liquor Licences
15. Scaffolding fees
16. Bus stand fees
17. Forestry products fees
18. UPE contributions/fees
19. Weights and measures fees
20. Sale of fish (5 per cent Commission)
21. Refuse collection charges
22. Motor vehicle parking fees
23. Bye law fines
24. Entertainment levy
25. By-law permits charges
26. Medical examination fees
27. Abattoir slaughter fees
28. Water pipe installation fees
29. Storm water drainage fee
30. Cattle market charges
31. Inoculation/Vaccination fee
32. City building rent
33. NHC rent
34. Taxi registration fees
35. Burial fees
36. Fire service fees
37. Stray animals fine
38. Local Liquor licences
39. Livestock licence
40. Valuation fees
41. Cultural games fees
42. Fisheries licences
43. Foreign liquor licences
44. Playing grounds fees
45. Blood drying activity fees
46. Human resource licence
47. Ambulance fees
48. Hunting licences

B. OTHER REVENUE SOURCES

49. Bank Interest

50. Sale of assets
51. Hire of plants and vehicles
52. Sale of plants and seeds
53. Repayment of lost asset
54. Sale of identity cards
55. Recovery of public fund
56. Other income

For the purpose of budgeting, these sources can conveniently be subdivided into three categories:
(a) rates, i.e. development levy, property tax and produce cess; (b) miscellaneous receipts i.e.
various fees, charges for services (user charges) and rents; and (c) contributions and grants from
the government.

The sources can further be considered on the basis of "own" sources and grants (or subsidies)
from the central government. One clear feature of local authority finance in Tanzania is the
dependence of both rural and urban authorities on central government grants. During the period
1984-1996, this varied between 55 per cent and over 70 per cent.

In the own revenue category, the main sources of revenue are: development levy, business
licence, property tax, road licence fees, industrial/produce cess, hotel levy, taxi/pick up/lorry
fees, and petrol levy.

Asdgfds

Every March, June, September and December my company pays 0.3% of Total Turnover to the
municipal for City service Levy.And All Companies operating in Tanzania should be doing the
same.
Service Levy is one of the sources of Local Government Own Revenues. LGAs tax collections
is the responsibility of the councils and is completely separated from the central government.

In District Councils Revenue collection is organised around 3 levels; Council Headquaters, the
wards and Village levels.

City Service Levy is imposed to Corporates at a rate 0.3% of turnover payable quaterly.

My Question; Do all Companies operating in Tanzania pay City Service Levy? In Time? I bet
most of them do not even know this tax exist.

1.4 government intervention in the market

Should be noted that the government intervention in the market is due to market failure or
the situation where by the price mechanism failed to allocate the scarce resources
effectively so before seen the government intervention in the market and how is intervene
the market lets get the knowledge of market failure first before seen how the government
intervene the market.

Market failure

Introduction
Market failure occurs whenever markets fail to deliver an efficient allocation of resources
and the result is a loss of economic and social welfare.

Market failure exists when the competitive outcome of markets is not satisfactory from the point
of view of society. What is satisfactory nearly always involves value judgments.

Complete and partial market failure

 Complete market failure occurs when the market simply does not supply products at all - we
see “missing markets”
 Partial market failure occurs when the market does actually function but it produces either the
wrong quantity of a product or at the wrong price.

Markets can fail for lots of reasons:

Negative externalities (e.g. the effects of environmental pollution) causing the social cost of
production to exceed the private cost

Positive externalities (e.g. the provision of education and health care) causing the social benefit
of consumption to exceed the private benefit

Imperfect information or information failure means that merit goods are under-produced
while demerit goods are over-produced or over-consumed

The private sector in a free-markets cannot profitably supply to consumers pure public goods
and quasi-public goods that are needed to meet people’s needs and wants

Market dominance by monopolies can lead to under-production and higher prices than would
exist under conditions of competition, causing consumer welfare to be damaged

Factor immobility causes unemployment and a loss of productive efficiency

Equity (fairness) issues. Markets can generate an ‘unacceptable’ distribution of income and
consequent social exclusion which the government may choose to change

Government Intervention in the Market

In a free market economic system, scarce resources are allocated through the price
mechanism where the preferences and spending decisions of consumers and the supply
decisions of businesses come together to determine equilibrium prices. The free market
works through price signals. When demand is high, the potential profit from supplying to a
market rises, leading to an expansion in supply (output) to meet rising demand from
consumers. Day to day, the free market mechanism remains a tremendously powerful device
for determining how resources are allocated among competing ends.

Intervention in the market

The government may choose to intervene in the price mechanism largely on the grounds of
wanting to change the allocation of resources and achieve what they perceive to be an
improvement in economic and social welfare. All governments of every political persuasion
intervene in the economy to influence the allocation of scarce resources among competing
uses

What are the main reasons for government intervention?

The main reasons for policy intervention are:

 To correct for market failure

 To achieve a more equitable distribution of income and wealth
 To improve the performance of the economy

Options for government intervention in markets

There are many ways in which intervention can take place – some examples are given below

Government Legislation and Regulation

Parliament can pass laws that for example prohibit the sale of cigarettes to children, or ban
smoking in the workplace. The laws of competition policy act against examples of price-
fixing cartels or other forms of anti-competitive behaviour by firms within markets.
Employment laws may offer some legal protection for workers by setting maximum
working hours or by providing a price-floor in the labour market through the setting of a
minimum wage.

The economy operates with a huge and growing amount of regulation. The government
appointed regulators who can impose price controls in most of the main utilities such as
telecommunications, electricity, gas and rail transport. Free market economists criticise the
scale of regulation in the economy arguing that it creates an unnecessary burden of costs for
businesses – with a huge amount of “red tape” damaging the competitiveness of businesses.

Regulation may be used to introduce fresh competition into a market – for example breaking
up the existing monopoly power of a service provider. A good example of this is the attempt
to introduce more competition for British Telecom. This is known as market liberalisation.

Direct State Provision of Goods and Services

Because of privatization, the state-owned sector of the economy is much smaller than it was
twenty years ago. State funding can also be used to provide merit goods and services and
public goods directly to the population e.g. the government pays private sector firms to carry
out operations for NHS patients to reduce waiting lists or it pays private businesses to operate
prisons and maintain our road network.
Fiscal Policy Intervention

Fiscal policy can be used to alter the level of demand for different products and also the
pattern of demand within the economy.
(a) Indirect taxes can be used to raise the price of de-merit goods and products with negative
externalities designed to increase the opportunity cost of consumption and thereby reduce
consumer demand towards a socially optimal level
(b) Subsidies to consumers will lower the price of merit goods. They are designed to boost
consumption and output of products with positive externalities – remember that a subsidy
causes an increase in market supply and leads to a lower equilibrium price
(c) Tax relief: The government may offer financial assistance such as tax credits for
business investment in research and development. Or a reduction in corporation tax (a tax
on company profits) designed to promote new capital investment and extra employment
(d) Changes to taxation and welfare payments can be used to influence the overall
distribution of income and wealth – for example higher direct tax rates on rich households or
an increase in the value of welfare benefits for the poor to make the tax and benefit system
more progressive

Intervention designed to close the information gap

Often market failure results from consumers suffering from a lack of information about the
costs and benefits of the products available in the market place. Government action can have
a role in improving information to help consumers and producers value the ‘true’ cost
and/or benefit of a good or service. Examples might include:

 Compulsory labelling on cigarette packages with health warnings to reduce smoking

 Improved nutritional information on foods to counter the risks of growing obesity
 Anti speeding television advertising to reduce road accidents and advertising campaigns to
raise awareness of the risks of drink-driving
 Advertising health screening programmes / information campaigns on the dangers of
addiction

These programmes are really designed to change the “perceived” costs and benefits of
consumption for the consumer. They don’t have any direct effect on market prices, but they
seek to influence “demand” and therefore output and consumption in the long run. Of course
it is difficult to identify accurately the effects of any single government information
campaign, be it the campaign to raise awareness on the Aids issue or to encourage people to
give up smoking. Increasingly adverts are becoming more hard-hitting in a bid to have an
effect on consumers.

The effects of government intervention

One important point to bear in mind is that the effects of different forms of government
intervention in markets are never neutral – financial support given by the government to one
set of producers rather than another will always create “winners and losers”. Taxing one
product more than another will similarly have different effects on different groups of
consumers.

The law of unintended consequences

Government intervention does not always work in the way in which it was intended or the
way in which economic theory predicts it should. Part of the fascination of studying
Economics is that the “law of unintended consequences” often comes into play – events can
affect a particular policy, and consumers and businesses rarely behave precisely in the way in
which the government might want! We will consider this in more detail when we consider
government failure.

Judging the effects of intervention – a useful check list

To help your evaluation of government intervention – it may be helpful to consider these

questions:

Efficiency of a policy: i.e. does a particular intervention lead to a better use of scarce
resources among competing ends? E.g. does it improve allocative, productive and dynamic
efficiency? For example - would introducing indirect taxes on high fat foods be an efficient
way of reducing some of the external costs linked to the growing problem of obesity?

Effectiveness of a policy: i.e. which government policy is most likely to meet a specific
economic or social objective? For example which policies are likely to be most effective in
reducing road congestion? Which policies are more effective in preventing firms from
exploiting their monopoly power and damaging consumer welfare? Evaluation can also
consider which policies are likely to have an impact in the short term when a quick response
from consumers and producers is desired. And which policies will be most cost-effective in
the longer term?

Equity effects of intervention: i.e. is a policy thought of as fair or does one group in society
gain more than another? For example it is equitable for the government to offer educational
maintenance allowances (payments) for 16-18 year olds in low income households to stay on
in education after GCSEs? Would it be equitable for the government to increase the top rate
of income tax to 50 per cent in a bid to make the distribution of income more equal?

Sustainability of a policy: i.e. does a policy reduce the ability of future generations to
engage in economic activity? Inter-generational equity is an important issue in many current
policy topics for example decisions on which sources of energy we rely on in future years

The role of the government is to protect property rights, uphold the rule of law and maintain the
value of the currency.
competitive markets often deliver improvements in allocative, productive and dynamic
efficiency

But there are occasions when they fail – providing a case for intervention.

Intervention and Stakeholders

As an economist, whenever you are required to discuss the costs and benefits of an example of
government intervention it is worth asking yourself “who are the major stakeholders in this
issue?”

A stakeholder is any person or organization that has a legitimate interest in a specific project or
policy decision.

The decisions of government, businesses and other organisations inevitably affect different
groups within society. Increasingly, many businesses are taking into account the effects of their
actions not just on the value that such decisions create for shareholders – but also to a broader
range of stakeholder groups.

Typically stakeholder issues come into play on major infrastructural projects where a cost benefit
analysis might be undertaken to assess the likely social costs and benefits – it is important to
bring as many stakeholders into the picture as possible – many people might be affected,

Stakeholders are affected by

Legislation
Direct government provision of merit & public goods
Taxation
Subsidies
Tradable permits
Extension of property rights
Advertising to encourage or discourage consumption
International cooperation among governments

Examples of stakeholders you might think of bringing into a

discussion
1. Employees of a business / organisation (who may / may not be members of a union)
2. Communities where a business is located or affected directly by a decision
3. Suppliers to a particular business (e.g. back down the supply chain)
4. Shareholders and other investors / financiers
5. Creditors (people owed money)
6. Government (and through them – taxpayers)
7. Trade unions (and the workers they represent)
8. Professional associations
9. NGOs and other advocacy groups (i.e. World Bank, IMF, Pressure Groups)
 10. Prospective employees
11. Prospective customers
12. Local communities
13. National communities
14. International community
15. Competitors within a market

1.5 externalities

Many types of activity give rise to externalities. And these externalities can be positive and
negative.

Externalities are third party effects arising from production and consumption of goods and
services for which no appropriate compensation is paid.

Externalities occur outside of the market i.e. they affect people not directly involved in the
production and/or consumption of a good or service. They are also known as spill-over effects.

Economic activity creates spill over benefits and spill over costs – with negative externalities
we focus on the spill over costs

Types of externalities

1. Positive externalities
2. Negative externalities

Negative externalities

Negative externalities occur when production and/or consumption impose external costs on
third parties outside of the market for which no appropriate compensation is paid.

Example of negative externalities.

 Smokers ignore the harmful impact of toxic ‘passive smoking’ on non-smokers

 Air pollution from road use and traffic congestion and the impact of road fumes on lungs
 External costs of scraping the seabed for supplies of gravel
 The external cost of food waste
 The external costs of cleaning up from litter and the dropping of chewing gum
 The external costs of the miles that food travels from producer to the final consumer
 The externalities linked to the oil sands project in the Canadian wilderness

The importance of property rights

 Property rights confer legal control or ownership of a good.

 For markets to operate efficiently, property rights must be protected – perhaps through
regulation.
  Put another way, if an asset is un-owned, no one has an incentive to protect it from abuse. The
right to own property is an essential building block of a market-based system
 Failure to protect property rights may lead to what is known as the Tragedy of the Commons -
examples include the over use of common land and the long-term decline of fish stocks caused
by over-fishing which leads to long term permanent damage to the stock of natural resources.

Private Costs and Social Costs

The existence of externalities creates a divergence between private and social costs of
production and the private and social benefits of consumption.

Social Cost = Private Cost + External Cost

Social Benefit = Private Benefit + External Benefit

When negative production externalities exist, social costs exceed private cost. This leads to
over-production if producers do not take into account the externalities.

Social costs are the total costs incurred by society from an economic action – they include
private and external costs

External costs from production

Production externalities are generated and received in supplying goods and services - examples
include noise and atmospheric pollution from factories.

External costs from consumption

 Consumption externalities are generated and received in consumption - examples include

pollution from driving cars and motorbikes and externalities created by smoking and alcohol
abuse and also the noise pollution created by loud music being played in built-up areas.
 Negative consumption externalities lead to a situation where the social benefit of consumption
is less than the private benefit.

Negative externalities from production – social cost > private

cost
Marginal cost or marginal benefit is the change in total cost or benefits that results from an
increase in production or consumption by one unit

In the absence of externalities, the private marginal costs of the supplier are the same as the
costs for society. But if there are negative externalities, we must add the external costs to the
firm’s supply curve to find the social marginal cost curve.

If the market fails to include these external costs, then the private equilibrium output will be Q1
and the price P1 where private marginal cost = private marginal benefit.

From a social welfare viewpoint, we want less output from activities that create an “economic-
bad” such as pollution. A socially-efficient output would be Q2 with a higher price P2. At this
price level, the external costs have been taken into account. We have not eliminated the pollution
– but at least the market has recognised them and priced them into the price of the product.

Economic and Social Welfare

Private economic welfare requires us to consider only the private (or internal) costs and benefits
of production and consumption of goods and services.

But if we wish to look at the economic welfare of the whole community (i.e. the social welfare)
then we need to calculate the positive and negative externalities and add them to private benefits
and costs. Here is a simple numerical example:
A government is considering four possible capital investment projects. It has the resources to
finance and implement only one of these projects. The table below shows the estimated value of
the private and external costs and benefits that each project is expected to yield:

New city by-pass New schools Improvement to an New hospitals

(£ million) (£ million) existing airport (£ million)
(£ million)
Private benefits 50 135 130 80
Private costs 120 80 100 65
Positive externalities 90 55 35 120
Negative externalities 60 20 60 45
Net private benefit -70 +55 +30 +15
Net social benefit -40 +80 +5 +90

Net social benefit may be taken into account by a government when deciding which project
offers the best potential return for society as a whole

Negative Externalities and Government Intervention

To many economists interested in environmental problems the key is to internalise external
costs and benefits to ensure that those who create the externalities include them when making
decisions.

Pollution Taxes

One common approach to adjust for externalities is to tax those who create negative externalities.

 This is known as “making the polluter pay”.

 Introducing a tax increases the private cost of consumption or production and ought to reduce
demand and output for the good that is creating the externality.
 Some economists argue that the revenue from pollution taxes should be ‘ring-fenced’ and
allocated to projects that protect or enhance our environment.
 For example, the money raised from a congestion charge on vehicles entering busy urban roads,
might be allocated towards improving mass transport services; or the revenue from higher taxes
on cigarettes might be used to fund better health care programmes.

Examples of Environmental Taxes include some of the following

 The Landfill Tax - this tax aims to encourage producers to produce less waste and to recover
more value from waste, for example through recycling or composting and to use
environmentally friendly methods of waste disposal.
 The Congestion Charge: -this is a high profile environmental charge introduced in February
2003. It is designed to cut traffic congestion in inner-London by charging motorists £8 per day to
enter the central charging zone.
  Plastic Bag Tax: A tax on plastic bags in Wales has seen the number given away drop by sizeable
amounts according to this news report Since 1 October 2011, there has been a minimum charge
of 5p on all single use carrier bags. The Welsh government acted in a bid to encourage re-use of
bags and therefore lower demand for single-use free bags. The justification was on economic
and environmental grounds:
 Vehicle excise duty (VED): Also known as ‘road tax’ – VED starts from a theoretical 'nil' rate and
accelerating up depending on the carbon emissions of the vehicle

Problems with Environmental Taxes

Many economists argue that pollution taxes can create problems which lead to government
failure.

 Assigning the right level of taxation: There are problems in setting tax so that private cost will
exactly equate with the social cost.
 Consumer welfare effects: Producers may pass on the tax to the consumers if the demand for
the good is inelastic and, as result, the tax may only have a small effect in reducing demand.
Taxes on some de-merit goods (for example cigarettes) may have a regressive effect on lower-
income consumers and leader to a widening of inequalities in the distribution of income.
 Employment and investment consequences: If pollution taxes are raised in one country,
producers may shift to countries with lower taxes. This will not reduce global pollution, and may
create problems such as structural unemployment and a loss of international competitiveness.

Externalities and Regulation

 The government may intervene through the use of regulations and laws.
 For example, the Health and Safety at Work Act covers all public and private sector businesses.
Local Councils can take action against noisy, unruly neighbours and can pass by-laws preventing
the public consumption of alcohol. The British government introduced a ban on smoking in
public places from July 1st 2007.
 The European Union has introduced directives on how consumer durables such as cars,
batteries, fridges freezers and other products should be disposed of. The onus is now on
producers to provide facilities for consumers to bring back their unwanted products.

Carbon Emissions Trading

The EU Emissions Trading Scheme (EUETS) was launched in 2005 and is a market-based
mechanism to incentivise reduction of C02 emissions in a cost-effective and efficient manner.

The EU scheme operates through the trade of CO2 emissions allowances. It creates a market in
the right to emit C02. One allowance represents one tonne of C02 equivalent. Companies get
most permits free now but many electricity generators in Europe will have to pay for all these
from 2013.
A cap is set on emissions – this creates the scarcity required for the market. At the end of each
year businesses are required to ensure they have enough allowances to account for their
installation’s actual emissions. There are heavy fines for those without such permits.

The aim of carbon trading is to create a market in pollution permits and put a price on carbon. In
this way, policy can help internalize environmental costs of firms’ production and encourage
lower emissions to tackle climate change

In a cap and trade system, the number of available permits would gradually decline. As the price
of the permits rises, so the economics of investing in cleaner technologies will change. The hope
is that businesses will look for ways of reducing c02 emissions in the most efficient way possible

Supply and demand analysis diagrams can be used when discussing carbon trading schemes.
The idea is to gradually cut the supply of permits so that the carbon price is sufficiently high to
incentivise businesses to look for ways to cut their total emissions in the most cost-efficient way.

Subsidising positive externalities

 An alternative to taxing activities that create negative externalities is to subsidise activities that
lead to positive externalities
 This reduces the costs of production for suppliers and encourages a higher output
 For example the Government may subsidise state health care; public transport or investment in
new technology for schools and colleges to help spread knowledge and understanding
 There is also a case for subsidies to encourage higher levels of training as a means to raise
labour productivity and improve our international competitiveness.
 

1.6 Public finance through state enterprise

Further information: State-owned enterprise

Public finance in centrally planned economies has differed in fundamental ways from that in
market economies. Some state-owned enterprises generated profits that helped finance
government activities. The government entities that operate for profit are usually manufacturing
and financial institutions, services such as nationalized healthcare do not operate for a profit to
keep costs low for consumers. The Soviet Union relied heavily on turnover taxes on retail sales.
Sales of natural resources, and especially petroleum products, were an important source of
revenue for the Soviet Union.

In market-oriented economies with substantial state enterprise, such as in Venezuela, the state-
run oil company PSDVA provides revenue for the government to fund its operations and
programs that would otherwise be profit for private owners. In various mixed economies, the
revenue generated by state-run or state-owned enterprises are used for various state endeavors;
typically the revenue generated by state and government agencies goes into a sovereign wealth
fund. An example of this is the Alaska Permanent Fund and Singapore's Temasek Holdings.

Various market socialist systems or proposals utilize revenue generated by state-run enterprises
to fund social dividends, eliminating the need for taxation altogether.

Government Finance Statistics and Methodology

Macroeconomic data to support public finance economics are generally referred to as fiscal or
government finance statistics (GFS). The Government Finance Statistics Manual 2001 (GFSM
2001) is the internationally accepted methodology for compiling fiscal data. It is consistent with
regionally accepted methodologies such as the European System of Accounts 1995 and consistent
with the methodology of the System of National Accounts (SNA1993) and broadly in line with its
most recent update, the SNA2008.

Measuring the public sector

The size of governments, their institutional composition and complexity, their ability to carry out
large and sophisticated operations, and their impact on the other sectors of the economy warrant
a well-articulated system to measure government economic operations.

The GFSM 2001 addresses the institutional complexity of government by defining various levels
of government. The main focus of the GFSM 2001 is the general government sector defined as
the group of entities capable of implementing public policy through the provision of primarily
nonmarket goods and services and the redistribution of income and wealth, with both activities
supported mainly by compulsory levies on other sectors. The GFSM 2001 disaggregates the
general government into subsectors: central government, state government, and local government
(See Figure 1). The concept of general government does not include public corporations. The
general government plus the public corporations comprise the public sector (See Figure 2).

Figure 1: General Government (IMF Government Finance Statistics Manual

2001(Washington, 2001) pp.13

Figure 2: Public Sector(IMF Government Finance Statistics Manual 2001(Washington, 2001)

pp.15

The general government sector of a nation includes all non-private sector institutions,
organisations and activities. The general government sector, by convention, includes all the
public corporations that are not able to cover at least 50% of their costs by sales, and, therefore,
are considered non-market producers.[8]
In the European System of Accounts,[9] the sector “general government” has been defined as
containing:

 “All institutional units which are other non-market producers whose output is intended
for individual and collective consumption, and mainly financed by compulsory payments
made by units belonging to other sectors, and/or all institutional units principally engaged
in the redistribution of national income and wealth”.[8]

Therefore, the main functions of general government units are:

 to organize or redirect the flows of money, goods and services or other assets among
corporations, among households, and between corporations and households; in the
purpose of social justice, increased efficiency or other aims legitimized by the citizens;
examples are the redistribution of national income and wealth, the corporate income tax
paid by companies to finance unemployment benefits, the social contributions paid by
employees to finance the pension systems;
 to produce goods and services to satisfy households' needs (e.g. state health care) or to
collectively meet the needs of the whole community (e.g. defense, public order and
safety).

LECTURE 6:

TAX PLANNING, AVOIDANCE AND EVASION

Objectives

 At the end of this lecture you will be able:

 Distinguish between tax avoidance and tax evasion and explain their causes and consequences
 Identify general practices through which a taxpayer (including a multinational company) can
eliminate or minimize tax liability through tax avoidance and evasion
 Identify any provisions under Income Tax Act (2004) that are designed to combat tax avoidance
 Explain the ways that can be employed to minimize tax avoidance and evasion
 Explain the aspects of tax planning

Content

 Meaning of tax planning, avoidance and evasion

 Tax avoidance and evasion practices
  Combating and minimization of tax avoidance and evasion
 Meaning and aspects of tax planning

6.2 Tax avoidance and evasion practices

6.3 Combating and minimization of tax avoidance and evasion

6.4 Meaning and aspects of tax planning

6.1 Meaning of tax planning, avoidance and evasion

Introduction

The problem of tax avoidance and evasion is common in all tax systems. All tax authorities have
to contend and live with the problem. While the evil practice cannot be eliminated it can only be
minimized because it is planned and undertaken in secrecy by the taxpayer and sometimes with
the cooperation of tax consultant and auditor. Otherwise the tax authorities would have pre-
emptied any tax evasion and avoidance practices. A high degree of tax avoidance and evasion
may result into serious Government revenue shortfalls leading into non-realization of
government and economic and social development programmes, and bring inequality in the tax
system that may necessitate higher tax rates to compensate for the revenue loss than what the
rates would otherwise have been. It is therefore in the interest of the country to keep the level of
tax avoidance and evasion to as the minimum as possible.
Tax Avoidance
Tax avoidance is the practice and technique whereby one so arranges his business affairs such
that he pays little or no tax at all but without contravention of the tax laws. Tax
avoidance takes advantage of any loopholes and weaknesses, deficiencies and loose
or vague clauses in the tax legislations to minimize or eliminate tax liability altogether.
Tax avoidance is not punishable in law. Where the tax authorities detect the practice, the only
solution is to amend the law in order to plug the loopholes and weaknesses in the laws that allow
the possibility of tax avoidance. It is for this reason that the practice of tax avoidance is
sometimes considered as legally allowed. However, this does not mean that the tax authorities
will allow the practice. For example, the taxpayer who claims the maximum permissible
deductions in any particular year(s) of income such as through acquisition of assets that allow the
highest capital deductions (e.g. clearing or clearing and planting permanent or semi-permanent
crops, acquisition of class I or class 8 assets for depreciable allowances/wear and tear purposes
etc.) constitute tax avoidance.
Similarly, there is no law that prevents anyone from changing his business organization from a
sole proprietorship into a partnership or limited liability company. Whereas tax consideration
may influence the change in the form of business organization, there may be other good reasons
to justify the change such as the need to raise more capital for business expansion or attract
necessary skills etc. It may also constitute legitimate tax planning where assets are leased instead
of ownership because the higher lease rent is allowable over a shorter period instead of the
smaller amount of depreciation allowance claims over a longer period of time. In all these cases
there is no contravention of any law. The taxpayer merely looks at the existing legal framework
to structure his business transactions to realize the maximum tax savings.
Tax Evasion
Tax evasion on the other hand involves a taxpayer’s deliberate contravention of the tax law(s) in
order to minimize or eliminate tax liability altogether (pay no or little tax respectively by
breaking the law). Tax evasion is the application of fraudulent practices in order to minimize or
eliminate tax liability.
Typical examples of tax evasion:

 Making a false return of income by omitting or understating income or overstating

expenses.
 Making a false statement in a return affecting tax liability
 Giving false information on any matter affecting tax liability
 Preparation or maintenance of false books of accounts or records
 Application of fraud e.g. manipulation of stock sheets and valuation, destruction of or
defacing of accounting records, non-issue of sales receipts etc.

Where such acts are made with intent to evade tax or assist another person to evade tax it
constitutes fraud or gross neglect, which is heavily punishable by law.
Proof of fraud
It is essential that before such heavy penalties are imposed proof of fraud or gross (willful)
neglect have to be established by the commissioner. Not all acts by a taxpayer may constitute
evasion. It all depends on the amount involved and the prevailing circumstances. The omission
of an item of income, false claim of expenditure or the wrong total amount by design but a
genuine error of omission or arithmetic: the frequency of such errors, the amounts involved, the
seniority and experience of staff or person who caused the error/false statement and other
considerations should all be considered to establish the existence of fraud.
Where fraud is not established simple or minor omissions/errors are resolved by simple sanctions
such as under:
· Section 98 (imposition of penalty for failure to maintain documents or failure to file statement
or return of income),

 section 100 (imposition of late payment interest),

 section 99 (penalty for underestimation of estimated tax/making misleading statements),
 etc

Tax planning

 Logical analysis of a financial situation or plan from a tax perspective, to align financial
goals with tax efficiency planning. The purpose of tax planning is to discover how to
accomplish all of the other elements of a financial plan in the most tax-efficient manner
possible. Tax planning thus allows the other elements of a financial plan to interact more
effectively by minimizing tax liability.
  INVESTOPEDIA EXPLAINS 'Tax Planning'
 Tax planning encompasses many different aspects, including the timing of both income
and purchases and other expenditures, selection of investments and types of retirement
plans, as well as filing status and common deductions. However, while tax planning is an
important element in any financial plan, it is important to not let the "tax" tail wag the
financial "dog." This can ultimately be counterproductive, as virtually all courses of
financial action will have some tax consequences, and they should not be avoided solely
on this basis.

Causes of Tax Avoidance and Evasion

Any attempt to avoid or evade tax may be caused by any one or combination of the following
factors: -

i. High marginal tax rates and frequent changes in tax rates such as ales tax and import
duty, withholding tax etc. because taxpayers may consider distribution of their incomes
unfair and may attempt to make a unilateral adjustment for equity by non-compliance
through tax evasion.
ii. Administrative inefficiency, collusion with taxpayers and bribery of tax officials.
Financial constraints, inadequate working tools and lack of staff motivation do not
encourage tax compliance. Income may go untaxed and tax collection is delayed for
various reasons.
iii. Inadequate training and experience of tax administrators coupled with lack of exposure to
business practices may limit tax officials’ ability to expose complex international and
intercom any tax avoidance schemes and check on stock manipulations or proper
accounting in long term contracts.
iv. Too many taxes (multiplicity of taxes) are difficult to comply with correctly due to lack
of knowledge of the detailed provisions of all the tax laws, too many due dates and too
much return to complete, accounting staff shortages and different complexities in the
laws etc. There are more than 30 tax laws in Tanzania. There is a need to rationalize the
tax regime further.
v. Low prospect of detection and punishment of tax evaders. The more tax evaders a person
know who are not caught and punished, the more likely he will also join the band wagon
of tax evaders (induced evasion). Where tax evaders are caught the penalty should be
sufficiently deterrent. That is why a selective prosecution policy is necessary. However
w.e.f.1/7/1997 the penalties for non-compliance appear too harsh and arbitrarily enforced.
vi. Deficiencies in the legal structure of the tax laws (poor draftsmanship) and complexity
allow tax avoidance.
vii. Traditional and cultural tendency to hate and evade taxes (low tax morality): In Tanzania
tax evasion seems to generate some sense of cheap heroism to the evaders. The practice is
generally not seen by the society as a stigma.
viii. The wasteful manner in which the Government departments spend the revenue and lack
of clear benefits to taxpayers through improved social services has some negative
influence on tax compliance.
Effects (consequences) of Tax Avoidance and evasion
Although the concepts of tax avoidance and tax evasion are different, the purpose and net effect
of these concepts are exactly the same i.e. the reduction or elimination of tax liability resulting
into:
Government revenue loss leading to non-realization of budget plans and objectives for economic
and social development;
Non-realization of other non-revenue goals of taxation e.g. inequality in taxation, as some law
abiding citizens or those with no opportunity to evade tax such as employees, bear a
disproportional heavier tax burden than others;
Alternative sources of government revenue such as the running of government budget deficits is
inflationary and foreign loans/grants dependency causes heavy foreign debt burden (loan
repayment with interest drains foreign reserves) and may be politically undesirable.
How to Minimize Tax Avoidance and Evasion
It becomes relatively easier to design effective ways and means of fighting tax avoidance and
evasion if we know the causes. All efforts should go towards minimizing or containing the
causes.
In the light of the above causes of tax avoidance and evasion the following should be undertaken.

 Keep the marginal tax rates low, bearable and not subject to frequent changes.
 Promote administrative efficiency by providing better tools (e.g. computers, transport
etc.), adequate financial resources and staff motivation (good salaries, housing,
promotions etc.).
 Carry out technical staff training on accountancy, tax laws, exchange visits with other
countries, practical business exposure and taxpayer education especially for small
businessmen to encourage voluntary compliance.
 Carry out a major selective prosecution policy and punishment particularly on major
taxpayers with a view to punish them for deterrence effect. Tax officials may be punished
for corruption and inefficiency.
 Avoid multiplicity of taxes by retaining a few major productive taxes only to make easier
administration and compliance.
 Design clear and simple tax laws and avoid ambiguity (better legal draftsmanship of the
laws)
 Judicious and rational expenditure of revenue by the government. If taxpayers see that
their taxes are well spent, voluntary compliance is likely to improve.

Government policy towards tax avoidance and evasion

On the basis of the above negative implications arising from tax avoidance and evasion the
government policy will fight against and discourage both practices of tax avoidance and evasion
(e.g. s. 33 to s.35 – tax avoidance arrangements). Some other provisions against tax avoidance
and evasion are under sections 98 to 124 of the ITA 2004. The other tax policy tool particularly
against tax avoidance is to enact timely amendments of pensive of the tax acts wherever it is
detected those certain provisions of the law allow tax avoidance in a major scale. The timely
amendment of the law is in the nature of preventive tax maintenance to pre-empt possible
avoidance and evasion.
Tax planning

The goal of tax planning is to arrange your financial affairs so as to minimize your taxes. There
are three basic ways to reduce your taxes, and each basic method might have several variations.
You can reduce your income, increase your deductions, and take advantage of tax credits.

Reducing Income

Adjusted Gross Income (AGI) is a key element in determining your taxes. Lots of other things depend on
your AGI (or modifications to your AGI)-- such as your tax rate and various tax credits. AGI even impacts
your financial life outside of taxes: banks, mortgage lenders, and college

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 Business Tax Prep

 IRS Income Tax Return
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financial aid programs all routinely ask for your adjusted gross income. This is a key measure of your
finances.

Because your adjusted gross income is so important, you may want to begin your tax planning
here. What goes into your adjusted gross income? AGI is your income from all sources minus
any adjustments to your income. The higher your total income, the higher your adjusted gross
income. As you can guess, the more money you make, the more taxes you will pay. Conversely,
the less money you make, the less taxes you will pay. The number one way to reduce taxes is to
reduce your income. And the best way to reduce your income is to contribute money to a 401(k)
or similar retirement plan at work. Your contribution reduces your wages, and lowers your tax
bill.

You can also reduce your Adjusted Gross Income through various adjustments to income.
Adjustments are deductions, but you don't have to itemize them on the Schedule A. Instead, you
take them on page 1 of your 1040 and they reduce your Adjusted Gross Income. Adjustments
include contributions to a traditional IRA, student loan interest paid, alimony paid, and
classroom related expenses. A full list of adjustments are found on Form 1040, page 1, lines 23
through 34. The best way to boost your adjustments is to contribute to a traditional IRA.

As you can see, two of the best ways to reduce your taxes is to save for retirement, either through
a 401(k) at work or through a traditional IRA plan. Contributions to these retirement plans will
lower your taxable income, and lower your taxes.

Increase Your Tax Deductions

Taxable income is another key element in your overall tax situation. Taxable income is what's left over
after you have reduced your AGI by your deductions and exemptions. Almost everyone can take a
standard deduction, and some people are able to itemize their deductions.

Itemized deductions include expenses for health care, state and local taxes, personal property
taxes (such as car registration fees), mortgage interest, gifts to charity, job-related expenses, tax
preparation fees, and investment-related expenses. One key tax planning strategy is to keep track
of your itemized expenses throughout the year using a spreadsheet or personal finance program.
You can then quickly compare your itemized expenses with your standard deduction. You should
always take the higher of your standard deduction or your itemized deduction.

Your standard deduction and personal exemptions depends on your filing status and how many
dependents you have. You can increase your standard deduction and personal exemptions by
getting married or having more dependents.

The best strategies for reducing your taxable income is to itemize your deductions, and the three
biggest deductions are mortgage interest, state taxes, and gifts to charity.

Take Advantage of Tax Credits

Once we've tweaked our taxable income, we are ready to focus our attention on various tax credits. Tax
credits reduce your tax. There are tax credits for college expenses, for saving for retirement, and for
adopting children.

The best tax credits are for adoption and college expenses. Not everyone is in a position to adopt
a child, but everyone could take some college classes. There are two education-related tax
credits. The Hope Credit is for students in their first two years of college. The Lifetime Learning
Credit is for anyone taking college classes. The classes do not have to be related to your career.
You may also want to avoid additional taxes. If at all possible, avoid early withdrawals from an
IRA or 401(k) retirement plan. The amount you withdraw will become part of your taxable
income, and on top of that there will be additional taxes to pay on the early withdrawal.

One of the best, and most abused, tax credit is the Earned Income Credit (EIC). Unlike other tax
credits, the EIC is credited to your account as a payment. And that means the EIC often results in
a tax refund even if the total tax has been reduced to zero. You may be eligible to claim the
earned income credit if you earn less than a certain amount.

Increase Your Withholding

You can avoid owing at the end of the year by increasing your withholding. More money will be taken
out of your paycheck throughout the year, but you will get bigger refund when you file your taxes.

Tax planning

Tax Planning is closely related to tax avoidance and evasion. Therefore a discussion on tax
planning must inevitably begin from the definition and distinction between tax avoidance
and evasion. As discussed earlier, tax avoidance is the legal way to minimize tax liability
without contravention of the law in order to minimize tax liability.

Definition

Tax planning is the art and technique of careful structuring one’s future business
transactions in order to realize tax savings (minimization of tax liability) but without
contravention of the tax statutes (tax laws.) The concept of tax planning is thus more
closely related to tax avoidance rather than tax evasion.

Objectives of Tax Planning

The main objective of tax planning and tax avoidance is tax minimization or the
realization of tax savings or the elimination of tax liability altogether but within the legal
requirements.

However, the other objective of tax planning is to ensure the availability of adequate
funds to meet any tax obligations when it falls due for payment to avoid late payment
penalties.
It is of primary importance to carefully interpret and apply the tax laws. Proper planning
leads to tax minimization or avoidance, which is acceptable. Tax evasion , which is not
acceptable , cannot and should not be tolerated. However, it is necessary to quantify the
expected tax gain or saving before indulging in the exercise of tax planning. It is advisable
not to engage in blind tax planning schemes, which may be more expensive than an
anticipated imaginary gain. Any tax planning must be based on the cost-benefit analysis.

Guides to Tax savings

There are certain guideposts that can be used in tax planning. These will assist in achieving
the objective of tax planning: tax savings. The road to tax savings has at least ten main
branches. They point the direction tax-saving efforts should take. The following are some
of these guideposts:

Keep income stable to avoid top rate brackets.

Speed up or defer income and expenses to take advantage of anticipated higher or lower
tax rates

Spread income among several taxpayers.

Spread income over several years to keep out of higher tax brackets and postpone tax.

Transform ordinary income into long-term capital gain.

Take full advantage of all exemptions and deductions

Take advantage of elections e.g. when to claim specific deduction.

Use tax-free money to expand business operations.

Select the best form of your business operations.

Set up business deals along lines that make overall use of tax rates, earning potential,
losses and assets that can be depreciated.
The art and technique of tax planning

Successful tax planning may sometimes realize significant tax savings. However, it requires
a thorough knowledge of the tax legislation in both theory and practice. This is a clear
reference to the technical and practical competence of the tax consultant.

While intelligent and imaginative tax planning may result into substantial tax savings, the
tax planner should not ignore the significance of sound business management and
corporate financial planning and discipline. The two must go hand in hand. It should also
be noted that tax planning is a continual process during the whole year rather than a
decision to be made at the beginning or middle of the year and left to work itself out. A
series of actions or decisions may be necessary before the actual tax savings are realized.

Tax planning and avoidance is possible through two main areas:

Taking advantage of existing legal provisions that allow tax minimization.

Examples include tax shelters (capital expenditure that attracts favorable capital
deductions), indefinite loss carry forward provision, election when to claim specific
deductions e.g. Investment deduction, claim of capital expenditure against revenue income
allowed specifically by law e.g. Cost of clearing land and clearing and planting permanent
and semi-permanent crops etc.

Favorable interpretation of the statute especially on vague clauses, words and phrases
that have more than one meaning; e.g. “heavy industrial machinery” for the purposes of
wear and tear deduction.

The use of tax shelters in tax planning:

A tax shelter is a capital investment or expenditure on which the investor (taxpayer) is

entitled to claim capital allowances for tax purposes.
The cost of the capital investment is normally written off within a short period of time. Tax
sheltering is particularly applicable in the industrial, mining and manufacturing sectors,
which require heavy capital investment on plant, machinery and research and
development.

Tax sheltering is not relevant in the service and retail trading investment where heavy
plant and machinery is generally not required.

However, a tax shelter does not quite result into complete tax exemption or saving. It
merely defers the tax liability into future years when the write off of the capital cost
through capital deductions claim is exhausted. It is therefore important to provide for the
deferred tax. Alternatively the investor may ensure continued tax deferral by sustaining
the capital investment by periodic business expansion programmes and diversification. Yet
such sustained investment may not be easy in practice.

Pitfalls (dangers) in tax sheltering

Before any investment is undertaken to take advantage of a tax shelter, the investor may
wish to consider and guard against the fallowing pitfalls:

The certainty of the allowability of the capital deduction or write-off; The reliability of
the forecasts (data used) particularly on the profitability of the investment. Where the
investor makes losses the capital deductions are not immediately of any benefit; The
reliability, reputation and technical competence of the tax consultant undertaking the tax-
planning scheme. Is he infact capable of planning a successful tax-planning scheme? Is
there any resent evidence of previous successful tax planning scheme in a similar industry
and on a similar scale? If the answer is no, the end result may as well be a disaster!

The liquidity position of the investment project i.e. the investor should not tie up
substantial working capital into fixed assets to jeopardize the liquidity of the company. In
most such heavy investments loans are contracted hence the repayment schedule must be
carefully watched otherwise default in repayment may increase indebtedness by way of
interest.
Use of tax havens in tax planning

An investor may also resort to the use of tax havens in his planning efforts. Tax havens are
geographical regions or countries where the tax rates are deliberately kept very low or zero
in order to attract investors and savings. Remember that taxation is one of the major
considerations in investment decision-making process.

Features of tax haven:

Low tax rates

No exchange control restrictions. Transfers of cash into and out of the region or country
are completely free and unrestricted.

Complete secrecy of investments and finance particularly banking.

Provision of efficient and effective financial, (e.g. banking and insurance services), legal,
consultancy services and communication facilities.

No or little control on investments.

Some examples of tax havens are the Channel Islands, Liberia, Switzerland, Mauritius,
etc

Example of tax planning:

A plan of a tax efficient employee’s remuneration package.

The tax consultant is often required to advice on employees remuneration package that
attracts the minimum tax liability. The objective being to recruit and retain competent
employees by maximizing the take home pay (net salary) as one form of staff motivation for
increased efficiency. A lowly paid employee is inevitably inefficient and not committed to
his employment.
Although the scope of employees remuneration tax planning is limited (i.e. All allowances
are required to be consolidated for tax purposes), a possible tax efficient remuneration
package may explore the following areas: -

Provide free medical services (not taxable)

Provision of house by the employer- the maximum taxable benefit is 15% of the salary.

Government expenditures

Main article: Government spending

Economists classify government expenditures into three main types. Government purchases of
goods and services for current use are classed as government consumption. Government
purchases of goods and services intended to create future benefits – such as infrastructure
investment or research spending – are classed as government investment. Government
expenditures that are not purchases of goods and services, and instead just represent transfers of
money – such as social security payments – are called transfer payments.[3]

Government operations

Main article: Government operations

Government operations are those activities involved in the running of a state or a functional
equivalent of a state (for example, tribes, secessionist movements or revolutionary movements)
for the purpose of producing value for the citizens. Government operations have the power to
make, and the authority to enforce rules and laws within a civil, corporate, religious, academic,
or other organization or group.[4]

Financing of government expenditures

Budgeted revenues of governments in 2006.
Main article: Government revenue

Government expenditures are financed primarily in three ways:

 Government revenue
o Taxes
o Non-tax revenue (revenue from government-owned corporations, sovereign
wealth funds, sales of assets, or seigniorage)
 Government borrowing
 Printing of Money or inflation

How a government chooses to finance its activities can have important effects on the distribution
of income and wealth (income redistribution) and on the efficiency of markets (effect of taxes on
market prices and efficiency). The issue of how taxes affect income distribution is closely related
to tax incidence, which examines the distribution of tax burdens after market adjustments are
taken into account. Public finance research also analyzes effects of the various types of taxes and
types of borrowing as well as administrative concerns, such as tax enforcement.

Taxes

Main article: Tax

Taxation is the central part of modern public finance. Its significance arises not only from the
fact that it is by far the most important of all revenues but also because of the gravity of the
problems created by the present day tax burden[citation needed]. The main objective of taxation is
raising revenue. A high level of taxation is necessary in a welfare State to fulfill its obligations.
Taxation is used as an instrument of attaining certain social objectives i.e. as a means of
redistribution of wealth and thereby reducing inequalities. Taxation in a modern Government is
thus needed not merely to raise the revenue required to meet its ever-growing expenditure on
administration and social services but also to reduce the inequalities of income and wealth.
Taxation is also needed to draw away money that would otherwise go into consumption and
cause inflation to rise.[5]

A tax is a financial charge or other levy imposed on an individual or a legal entity by a state or a
functional equivalent of a state (for example, tribes, secessionist movements or revolutionary
movements). Taxes could also be imposed by a subnational entity. Taxes consist of direct tax or
indirect tax, and may be paid in money or as corvée labor. A tax may be defined as a "pecuniary
burden laid upon individuals or property to support the government [ . . .] a payment exacted by
legislative authority."[6] A tax "is not a voluntary payment or donation, but an enforced
contribution, exacted pursuant to legislative authority" and is "any contribution imposed by
government [ . . .] whether under the name of toll, tribute, tallage, gabel, impost, duty, custom,
excise, subsidy, aid, supply, or other name."[7]

 There are various types of taxes, broadly divided into two heads – direct (which is
proportional) and indirect tax (which is differential in nature):
 Stamp duty, levied on documents
 Excise tax (tax levied on production for sale, or sale, of a certain good)
 Sales tax (tax on business transactions, especially the sale of goods and services)
o Value added tax (VAT) is a type of sales tax
o Services taxes on specific services
 Road tax; Vehicle excise duty (UK), Registration Fee (USA), Regco (Australia), Vehicle
Licensing Fee (Brazil) etc.
 Gift tax
 Duties (taxes on importation, levied at customs)
 Corporate income tax on corporations (incorporated entities)
 Wealth tax
 Personal income tax (may be levied on individuals, families such as the Hindu joint
family in India, unincorporated associations, etc.)

Debt

Main article: Government debt

Governments, like any other legal entity, can take out loans, issue bonds and make financial
investments. Government debt (also known as public debt or national debt) is money (or credit)
owed by any level of government; either central or federal government, municipal government or
local government. Some local governments issue bonds based on their taxing authority, such as
tax increment bonds or revenue bonds.

As the government represents the people, government debt can be seen as an indirect debt of the
taxpayers. Government debt can be categorized as internal debt, owed to lenders within the
country, and external debt, owed to foreign lenders. Governments usually borrow by issuing
securities such as government bonds and bills. Less creditworthy countries sometimes borrow
directly from commercial banks or international institutions such as the International Monetary
Fund or the World Bank.

Most government budgets are calculated on a cash basis, meaning that revenues are recognized
when collected and outlays are recognized when paid. Some consider all government liabilities,
including future pension payments and payments for goods and services the government has
contracted for but not yet paid, as government debt. This approach is called accrual accounting,
meaning that obligations are recognized when they are acquired, or accrued, rather than when
they are paid. This constitutes public debt.
Seigniorage

Main article: Seigniorage

Seigniorage is the net revenue derived from the issuing of currency. It arises from the difference
between the face value of a coin or bank note and the cost of producing, distributing and
eventually retiring it from circulation. Seigniorage is an important source of revenue for some
national banks, although it provides a very small proportion of revenue for advanced industrial
countries.[citation needed]

Taxation

Tanzania's Tax Structure

Posted by Kessy Juma on Thursday, February 14, 2013
Introduction
Taxation is one of the oldest functions of a government in running government affairs. Apart
from the cost of running the government, normally there are some services which have to be met
by the state. Imperatively government have to provide social services, maintain law and order,
ensure defense and a horde of other undertakings which the free market cannot provide or which
the state feels are better provided by itself.
In this regard the government has to raise revenues to cater for such expenses thus, government
finance is all about budgeting the revenue and expenditure of government. The government
financier normally has five sources to choose from namely : taxes, the sale of goods and services,
grants, the creation of new money and borrowing. There is no universal formula of how the
government should raise such revenue to cater for government expenses, but in most cases the
government relies on taxes as a major means of raising such revenue. Therefore, out of the five
sources from which the government can raise her revenue, taxation is a handmaid for raising
revenue to meet government expenditure.
Thus, taxation is the primary source of revenue at all levels of government. Therefore by all
standards taxes are inevitable due to their inherent advantages over other sources of revenue. For
example, grants result into loss of liberty for the grantee government; the creation of new money
is inflationary in nature; borrowing is to shift the burden to future generations; but by imposing
taxes the government is not indebted to the taxpayers since there is no quid pro quo as to tax and
the government is not obliged to render individual account on how it has spent her money, but
rather to spend that money for the benefit of the people. In carrying out this function (of raising
revenue), government formulate tax policies, enact tax laws (statutes), and translate these
policies and statutes into the desired tax structure and administer its attainment.
Gains from investments
The income from investments include:- Any dividend, distribution of a trust, gains from life
insurance, gains from an interest in an unapproved retirement fund, interest, natural resources
payment, rent, or royalty, net gains from realization of investment assets (Capital gains),
amounts derived as a consideration for accepting a restriction of the capacity to conduct the
investment.

Indirect taxes
These are taxes, which are based on consumption. Examples of such taxes are like Import Duty,
Excise Duty, and Value Added Tax (VAT), etc. By definition the legal incidence of the tax falls
on the trader who acts as a collection agent of the government while the effective incidence falls
on the final consumer of goods or services who eventually pays the tax.

(i) Value Added Tax (VAT)

Value Added Tax is a consumption tax charged by VAT registered traders on all taxable goods
and services at a standard rate of 18%. The VAT is a multistage tax levied at each stage of
production and distribution up to the retail stage. The tax is also levied on taxable imports made
by persons whether or not registered for VAT. All exports are renovated (0%).

All traders or businesses whose taxable turnover exceeds Shs. 40 millions per annum or Shs.
10,000,000 in a period of three (3) consecutive months are obliged to apply for registration to the
Commissioner for Domestic Revenue within thirty (30) days of becoming liable to make such
application.

Application for VAT registration is done by filling the application form online or manually and
TRA inspect the business site before approving any registration. One registered, the taxpayer is
required to submit monthly VAT returns either with payment, repayment or a nil return to the
month following the month of business.

Some persons and institutions are relieved from the payment of VAT on supplies or on
importation of taxable goods and services, while some goods services are specifically exempted
from VAT.

Introduction of Electronic Fiscal Devices (EFDs)

The Government since 1st July 2010 introduced an Electronic Fiscal Device (EFD) System
aiming at enhancement of tax compliance. The System is being implemented in two phases with
the first phase planned to cover all VAT registered taxpayers countrywide based on their
turnover. In view of this decision, all VAT registered traders are obliged to ensure that they use
the System as prescribed in Value Added Tax (Electronic Fiscal Devices) Regulations, 2010.

According to Regulation 10 (2) of the value Added Tax (Electronic Fiscal Devices) Regulations,
2010 all taxable persons are not allowed to conduct or operate any business undertaking within
Mainland Tanzania without using Electronic Fiscal Devices. In order to minimize the cost of
implementing the regime, the Government meets the cost of purchasing the devices by
refunding.

Refunds to Outgoing non-citizen Passengers. With effect from 1st January 2012 the
Government through TRA started to process and make VAT refunds to eligible outgoing non-
citizen passengers who are departing to foreign destinations by using the Julius Nyerere
International Airport or Kilimanjaro International Airport. The value for the goods subject for
refund is shs. 400,000/=

(ii) Excise Duty on locally manufactured goods

Excise duty is levied on certain specified goods and services for soft drinks, beer, wines, spirits,
mobile phone services, plastic shopping bags, satellite television services, cigarettes and
petroleum products. The duty is charged either at specific or ad-valorem rates depending on the
type of goods.

Currently there are five ad-valorem rates: 7%, 10%, 20%, 30% and 120% (the highest rate of
120% is imposed on shopping plastic bags for the purposes of protecting the environment).

Most of the locally manufactured goods are charged excise duty at specific amount for a given
number or quantity. The items that are charged excise duty at specific rates include Cigarettes,
wines, spirits, beer, soft drinks (including bottled drinking water) and petroleum products.

Taxes on International Trade

The Customs and Excise Department administers all taxes on international trade, which are:
=> Import Duty,
=> Excise Duty on imports and,
=> Value Added Tax on imports.

(i) Import Duty

The East African Partner States have adopted the Common External Tariff that is applied
throughout the region from 1st January 2005. The process of harmonizing the external tariff has
resulted into changes in tariff rates and even tariff codes in certain areas. The rates applicable
with effect from 1st January 2005 are:
=> 0% for raw materials, capital goods, pharmaceuticals, hand hoes and agricultural implements,

=> 10% for semi-finished goods,

=> 25% for final consumer goods or finished commercial goods.

However, there are some sensitive goods which attract more than 25% duty rate, these include
yoghurt and cream containing sweetening matter, cane or beet sugar and chemically pure sucrose
in solid form, sacks and bags of a kind used for the packing of goods and worn clothing and
other worn articles.

(ii) Excise Duty on Imports

Excise duty is levied on certain specified imported goods like wines, spirits, cigarettes,
petroleum products and saloon cars and specified non-utility vehicles which are aged 10 years or
more from the date of manufacturing. The duty is charged either at specific or ad-valorem rates
depending on the type of goods.

(iii) Value Added Tax on Imports

VAT is levied on all goods and services imported into the country unless such goods or services
are specifically exempted. All importers must pay VAT regardless of whether or not registered
for VAT. However, the importer who is registered for VAT can claim as an input tax in his
business, the VAT paid on the imported goods and VAT or imported services the input tax is
treated as reverse charge hence added to the value.

(iv) Destination Inspection Fee

Following the introduction of Destination Inspection (DI) in July 1st 2004, imported goods are
not subjected to inspection at the country of origin but at their destination. In order to
complement the DI, mobile scanners were acquired whereby all containerized cargo are
categorized as red, yellow and green channel. Those in the red channel are subjected to physical
verification while those in yellow channel are scanned. Containers in the green channel are
released immediately. All imported goods regardless of their value are required to be inspected at
a fee of 0.6% on Free on Board (FOB) value.

Other Taxes

(ii) Stamp Duty

Stamp Duty is imposed on certain legal instruments or transactions, affidavit, conveyance &
lease Agreement. The rates used are 1% and Tsh. 500/-. The rate of 1% is based on the
consideration applicable to non business persons when issuing a receipt whenever they sale their
privately owned assets or properties.

In order to facilitate availability of credit in the financial sector and development of the stock
market the maximum stamp duty rate for registration of property for security or mortgage is
Tshs. 10,000. Stamp duty on conveyance for agricultural land is chargeable at Tshs. 500.

Proceeds of agricultural produce and school fees earned by government and privately owned
schools, colleges, training institutions, proceeds of game of of chance, rental income, sale of fish
by fishermen, receipts for business income and instruments when executed by Export Processing
Zones and Special Economic Zones are exempted from stamp duty. In addition, the transfers of
financial securities by companies listed by the Dar es Salaam Stock Exchange are exempted from
stamp duty.

(iii) Airport Service Charges

For the international travel a person has to pay USD 30 and a local travel Tshs. 5,000.

(iv) Port Service Charges

For the Resident and non-resident travel payment per trip is Tshs. 500 and USD 5 respectively.

(v) Motor Vehicle Registration tax and transfer fee

A person has to pay Tsh. 150,000 and 45,000 if he is registering a Motor Vehicle or Motorcycle
respectively. Alteration fee is Sh 10,000 while a new registration card costs Tsh 10,000. The
number plates are available to approved suppliers. Transfer fee for motor vehicle is Tshs. 50,000
and Tshs. 27,000 for motorcycle.

(vi) Motor Vehicle annual License fee

The motor vehicle annual fee is charged according to its engine capacity as follows:-

Motor Vehicle Annual License Fee [Source: Income Tax Act, 2004 (As amended)]
Engine Capacity Annual Fee
Not exceeding 500cc. Tshs 50,000
More than 500cc, but not exceeding 1,500cc Tshs. 100,000
More than 1,500, but not exceeding 2,500cc Tshs 150,000
More than 2,500cc Tshs. 200,000

Administration of Tax Structure

There are four departments that are involved directly in the administration of various tax laws.
These revenue departments are:-
1. Domestic Revenue Department (DRD),
2. Customs and Excise Department (CED),
3. Large Taxpayers Department LTD), and
4. Tax Investigation Department (TID).

The DRD deals with both direct and indirect taxes while CED is charged with a responsibility of
collecting indirect taxes on international trade. The other two departments of LTD and TID
complement the efforts of the DRD and CED.

Meaning of Tax > Characteristics of Tax > General Tax Classification >
Role of Taxation > Tanzania's Tax Structure >
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A tax is a compulsory contribution from a person to the state to defray the expenses incurred in the
common interest of all without any reference to the special benefits conferred. It is a compulsory
contribution or payment for the support of governmental or other public purposes.

=> De Marco defines tax as "a share of the income of citizens which the state appropriates in order to
procure for itself the means necessary for the production of general public services."

=> Charles M. Allen defines tax as "any leakage from the circular flow of income into the public sector,
excepting loan transactions and direct payments for publicly produced goods and services up to the
costs of producing these goods and services."

=> Professor Adams looks tax in the following way: "From the standpoint view of the state, a tax is a
source of derivative revenue; From the angle of the citizens, a tax is a coerced payment; From the
administrative point of view, it is a demand for money by state in conformity to established rules; From
the point of view of theory, a tax is a contribution from individuals for common expenditure."

=> Tax is the part of the price to be paid for living in an organized society.

=> Tax is a compulsory (not a voluntary) levy (charge) by the state on her citizens alike that is usually
payable in monetary form for which government needs not offer equivalent direct compensatory
services or render an individual account on how it has utilized the revenue.

Xstics of tax

It is a compulsory charge. It is not a donation, or a gift to the government. It is legally imposed and non-
compliance results into statutory, civil and criminal penalties. It is not a voluntary contribution.

=> Only the government (sovereign state) has power to levy taxes. So tax differ from other charges
which can be charged by even churches, clubs, political parties etc.

=> Both citizens and non-citizens may be liable to pay tax.

=> No 'quid-pro-quo' relationship in taxation. The benefits derived by paying tax are not necessarily
equal to the tax paid. Benefits defuse through general society or specific classes/groups in the society.

=> Government does not have the responsibility to provide an individual account of how tax is utilized.
Though this does not mean absence of public control over the government expenditure, political system
provide check and control mechanism.

=> Usually payable in monetary terms.

=> the power of taxation is mainly used in collecting state revenue.

Classfcation

=> Indirect tax: incidence falls on another person than the one paying the tax (tax impact).
Examples are taxes on consumption of goods/services - VAT, excise duty, etc.
Note: This classification is sometimes misleading as the incidence of some direct taxes, for
example corporate tax, can easily be shifted.

=> Factore that determine shiftability include:

(a) Market structure:
It is easy to shift tax incidence in an imperfect market due to its product differentiation and
imperfect communication characteristics. But it is very difficult to shift tax incidence in a perfect
market due to its many buyers&sellers, full knowledge, and lack of restrictions characteristics.
(b) Industry cost condition/structure:
In an industry with increasing cost structure it is very easy to shift tax incidence. In an industry
with constant cost structure it is possible to shift tax incidence. In an industry with decreasing
cost structure it is very easy to shift tax incidence.
(c) Type of tax:
It is very easy to shift tax incidence for the case of indirect tax but very difficult for the case of
direct tax.

3. Unit (specific) Vs ad-valorem based taxes.

=> A unit or specific tax - levied on the physical measure of what is being taxed (eg. volume,
weight, etc.). Many excise duties are specific taxes, for example tobacco tax is charged by
weight of tobbacco.
=> Ad-valorem tax - levied on the value of the tax base, for example income tax is charged on
the level of income, VAT on consumer expenditure, import duty.

4. Distribution of tax burden.

=> Progressive taxes - these tend to increase proportionately with the value of the tax base and
this results from the fact that Marginal Rate of Tax (MRT) being greater than Average Rate of
Tax (ART). Note: MRT equals to change in tax paid divided by change in income and ART
equals to total tax paid divided by total income.
=> Proportional taxes - these tend to remain constant when the tax base changes and results
from the fact that MRT being equal to ART. An instance of this could be all tax payers paying
30% of their corporate income.
=> Regressive taxes - these tend to decrease proportionately with the value of tax base and
results from the fact that MRT being less than ART. An instance of this could be a flat rate tax
on consumption such excise duty and VAT for essential goods.

Vat

eaning of VAT
Value Added Tax (VAT) is a general consumption tax assessed on the value added to goods and
services. It is a general tax that applies, in principle, to all commercial activities involving the
production and distribution of goods and the provision of services. It is a consumption tax
because it is borne ultimately by the final consumer. It is not a charge on companies. It is charged as
a percentage of price, which means that the actual tax burden is visible at each stage in the production
and distribution chain. It is collected fractionally, via a system of deductions whereby taxable persons can
deduct from their VAT liability the amount of tax they have paid to other taxable persons on purchases for
their business activities. This mechanism ensures that the tax is neutral regardless of how many
transactions are involved. ... Read More

Types of VAT
There are three types of VAT namely:
(i) Consumption type
(ii) Income type
(iii) Gross produced
(i) Consumption type:
Capital goods purchased are treated like any other purchases of input i.e. Full credit of input tax
are given. This type of VAT is practiced in Kenya, Uganda, Tanzania, Singapore and South
Africa.
(ii) Income type:
Input tax paid on the purchases of capital a goods is spread over the life span of the products or
Assets. The input tax credit with capital purchases against the liability in a particular tax period
will take into account the depreciation portion only. This type of VAT is practiced in Argentina
and Peru.
(iii) Gross product type:
Completely denies input tax deduction on capital goods against the firm VAT liability. VAT is
computed by subtracting from the firms sales only purchases apart from capital goods. This type
of VAT is practiced in Finland, Morocco and Senegal.
Read More
Advantages of VAT

VAT is perceived to have a very wide coverage and represents an important instrument against
tax evasion and is superior to a business tax or a sales tax from the point of view of revenue
security for three reasons:
1. Coverage - If the tax is carried through the retail level, it offers all the economic advantages of a tax
that includes the entire retail price within its scope, at the same time the direct payment of the tax is
spread out and over a large number of firms instead of being concentrated on particular groups, such as
wholesalers or retailers.

If retailers do evade, tax will be lost only on their margins because customers that are registered firms
gain nothing if their suppliers fail to collect tax, except delay in payment; they will pay more to the
government themselves. Under other forms of sales tax, both seller and customer gain by evading tax.
One particular advantage is that of the widening of the tax base by bringing all transactions into the tax
net. Specifically, VAT gives the government the opportunity to bring back into the tax system all those
persons and entities who were given tax exemptions in one form or another by the previous regime....
Read More

Disadvantages of VAT
VAT suffers from various disadvantages, first it is regressive, second it is too difficult to
administer, third it is inflationary and fourth it favors the capital intensive firm. It is claimed that
the tax is regressive, ie its burden falls disproportionately on the poor since the poor are likely to spend
more of their income than the relatively rich person. There is merit in this argument, particularly if it
attempts to replace direct or indirect taxes with steep, progressive rates. However, observation from
around the world has shown that steep tax rates lead to evasion, and in the case of income tax, it is a
disincentive to effort.

Further, there is now a tendency in most countries to reduce this progressivity of taxes as has been done
in Guyana where a flat rate of income tax has been introduced. In any case VAT recognises and makes
room for progressivity by applying no or low rates of tax on essential items such as food, clothes and
medicine. In addition it allows for steep rates of tax on luxury items, although this can create problems for
administration and open opportunities for evasion by way of deliberate misclassification, a problem
incidentally not peculiar to VAT, and which takes place extensively in the area of customs duties.... Read
More

Corporation

A corporation includes, for income tax purposes, any company or body corporate established,
incorporate established, incorporated or registered under any law in force in Tanzania or
elsewhere, and any unincorporated association or other body of persons, but excludes a
partnership or trust.

A corporation may have income from business and income from investment. Income from
investment means income from investments which are not related to the corporation's business.
The chargeable income of a corporation is calculated with the guidance of the income from
business page and income from investment page. The income of the corporation is obtained by
adding together the income from business and income from investment. The result of adding the
two is referred to as total income of the corporation.

However the Income Tax Act, 2004 allows a corporation to offset it's income by it's losses. The
discussion of offsetting income by losses is discussed at the offsetting losses page. You must
read the page together with the foreign source income page. The total income of the corporation
is taxed at 30%.

All corporations are required to account for income tax purposes on accrual basis (generally, this
means account for payments when the right to receive them is created, not when the payment
actually changes hands). All corporations are under self assessment system. For details see the
self assessment page. Corporations may also have an obligation to withhold tax from payments.
See withholding obligations page for more details.

Trust

What are trustees and trusts?

A trust is an arrangement whereby trustees hold assets for the benefit of beneficiaries. A trust can
be formed by personal acts, by a will, by an order or declaration of a court or sometimes by
operation of law.
Many charities in Tanzania are registered trusts who hold assets for the charitable purposes for
which they are formed. In many cases, the assets of a deceased person are held in trust by the
administrator of the will until they have been passed on to the beneficiaries of the will. A trust
may also be used to administer assets on behalf of children or incapacitated people.

How are trusts treated in the Income Tax Act?

A trust may have income from business and income from investment. The chargeable income is
calculated with the guidance of the income from business page and the income from investment
page. The income from business and income from from investment are then added together to get
the trust's total income. To find out about offsetting losses against positive income, see the
offsetting losses page. If the trust is a charity, there are some special rules for calculating income
- see the charity page. For special notes on foreign source income see the foreign source income
page. The total income of the trust will be taxed at a rate of 30%.

A trust may account for its business income on either a cash basis (accounting when a payment
changes hands) or an accruals basis (generally, accounting when the right to a payment is
created), depending on which basis most correctly reflects the trust's profits or gains. See also
timetable of returns and tax payments. All trusts are under the self-assessment system. For details
see the self assessment page. The trust may also have obligations to withhold tax from those it
pays - see withholding obligations.

How are beneficiaries of trusts treated in the Income Tax Act?

If the trust is resident in Tanzania, the distributions of the trust to its beneficiaries are exempt
from tax, that is, the beneficiary does not have to include the distribution in their income.
However, if the trust is not resident in Tanzania, the beneficiary must include the distribution of
the trust as part of his/her/its income.

Partnership

EFINING A PARTNERSHIP
Section 190 (1) of the Law of Contact Act defines a partnership as a relationship which subsists
between persons carrying on business in common as defined with a view of profit. (2) Persons
who have entered into partnership with one another are called collectively a "firm", and the name
under which their business is carried on is called the "firm name". The Income Tax Act, 2004
defines partnership as any association of individuals or bodies corporate carrying on business
jointly, irrespective of whether the association is recorded in writing. Therefore, partnership can
exist through a formal agreement or can be implied, oral or written.

TAXATION PRINCIPLES
A partnership is not a legal person and therefore NOT ASSESSED BUT partners are assessed
based on profit allocation (s.48). To limit tax avoidance (e.g. distribute taxable profit to fictitious
partners) there are some factors to be established. These are discussed below.

RULES FOR DETERMINING EXISTENCE OF A PARTNERSHIP

In determining whether a partnership does or does not exist, regard shall be had to the following
rules-
(a) joint tenancy, tenancy in common, joint property, common property or part ownership does
not of itself create a partnership as to anything so held or owned, whether the tenants or owners
do or do not share any profits made by the use thereof;
(b) the sharing of gross returns does not of itself create a partnership, whether the persons
sharing such returns have or have not a joint or common right or interest in any property from
which or from the use of which the returns are derived;
(c) the receipt by a person of a share of the profits of a business is prima facie evidence that he is
a partner in the business, but receipt of such a share, or of a payment contingent on or varying
with the profits of a business, does not of itself make him a partner in the business, and in
particular the receipt of such share
or payment–
(i) by a lender of money to persons engaged or about to engage in business;
(ii) by a servant or agent as remuneration;
(iii) by the widow or child of a deceased partner, as annuity; or
(iv) by a previous owner or part owner of the business, as consideration for the sale of the
goodwill or share
thereof,
does not of itself make the receiver a partner with the persons carrying on the business.

S.48(7)… if on the change of partners in a partnership at least two existing partners continue, the
partnership shall be treated as the same entity both before and after the change.

DETERMINATION OF PARTNERSHIP TAXABLE PROFIT & TAX LIABILITY OF

PARTNERS:

Section 48(2) of ITA, 2004 provides that, the partnership taxable income/loss shall be allocated
to the partners in accordance with some rules of the act. And as per requirements of section 50
(2), the partnership income/loss shall retain its character as to type and source, it shall also be
treated as an amount derived or expenditure incurred, respectively, by a partner at the end of the
partnership's year of income; and be allocated to the partners proportionately to each partner's
share, unless the Commissioner, by notice in writing, permits otherwise.

Section 50(4) of of ITA, 2004 provides that, a "partner's share" is equal to the partner's
percentage interest in any income of the partnership as set out in the partnership arrangement.
After partnership profit is appropriately allocated to partners, partners are taxed as individuals
under the 1st schedule Para. 1.

Types of tax

Basically made up of direct taxes and indirect taxes. The ministry of finance determines tax
structure and classification in Tanzania.

Direct Taxes are mainly taxes on income while indirect taxes are on consumption and
international trade.
=> Corporate tax - 30% of all companies (whether resident or none resident) carrying on a
business in Tanzania.

=> Individual Income Tax - non-corporate resident tax payers including sole proprietors and
salaried employees are taxed at progressive individual income tax rates, which vary from the
lowest marginal rate of 14% to the highest marginal rate of 30%. The total income of a non-
resident individual for a year of income is taxed at the rate of 20%.

=> Skills and development levy - a tax on the gross monthly emoluments paid by an employer
to employees.

=> Game of chance and Gambling Tax - charged to casinos, private lotteries and slot
machines.

=> Withholding taxes - a scheme, that is basically not a tax source in itself, that is operated on a
number of payments made by persons in course of doing businesses/investments. [eg. investment
income, etc].

Indirect Taxes:
=> Excise duty on locally manufactured goods - levied on few locally manufactured goods
which includes beer, wines, whiskeys, spirits, soft drinks, smoking tobacco, cigarettes, petroleum
products.

=> Stamp duty - certain legal instruments attract payment of stamp duty for the purpose of
authenticating them.

=> Value Added Tax (VAT) - a consumption tax charged on VAT registered traders for goods
and services at a standard rate of 18%.

=> Other Internal Taxes - fees, levies and user charges, which are
collected from various sources. e.g. taxes and charges on motor vehicles,
port and airport departure services.

=> Motor vehicle registration Tax

=> Motor vehicle transfer tax - on transferring the ownership of a motor

vehicle the new owner pays a transfer tax.

=> Port and Airport departure service charge

=> Import duty - generally known as customs duties. These are tariffs, which are imposed on
goods coming into the country.

=> Excise duty on imports - excise duty is charged either on specific or ad-valorem tax rate on
certain consumer goods into the country.
Tax avoidance

TRA

Individuals are categorized in two groups, small individual traders who are not required to
maintain audited accounts and the medium individual traders who are required to maintain
audited accounts. Small traders are tax by presumptive tax system, whereas medium are
taxed based on the annual profit determined from the audited accounts.

a) Presumptive tax system

This is a tax system where individuals are taxed based on their annual turnover. The
Taxpayers under this system are not obligated to prepare and submit audited accounts to
the TRA. However, he may opt not to apply the system and prepare audited accounts and
pay tax based on profits.

Conditions which qualify to be in Presumptive tax system.

 the Taxpayer must be a resident individual

 the annual turnover of the business does not exceed the threshold of TSHS 20
million.

 he must conduct business only for the year of income hence not be engaged in any
other activities such as employment or investments. Under the presumptive tax
system, individual’s income must be derived solely from business sources. If income
is derived from other sources such as employment and/or investment the
presumptive scheme cannot be used.

 the individual’s income for any year must consist exclusively of income from business
with sources in the United Republic of Tanzania.

Rates of tax under presumptive taxation.

Under this system, tax payable is established depending on the level of record keeping of
the taxpayer. Failure to keep complete records necessitates establishment of tax payable by
estimation settled between the TRA officers and taxpayers. There turnover bands and their
tax rates are as stipulated below:

Annual Turnover Tax Payable when Tax Payable when records

records are incomplete. are complete.
 Where turnover does not Nil Nil
exceed TSHS. 4,000,000
Where turnover exceeds TSHS. 100,000/= 2% of the turnover in excess
TSHS. 4,000,000 but does not of TSHS. 4,000,000
exceed TSHS. 7,500,000
Where turnover exceeds TSHS. 212,000/= 70,000+2.5% of the turnover
TSHS 7,500,000 but does not in excess of TSHS. 7,500,000
exceed TSHS. 11,500,000
Where turnover exceeds TSHS. 364,000/= 170,000+3.0% in excess of
TSHS 11,500,000 but does TSHS. 11,500,000
not exceed TSHS. 16,000,000

Where turnover exceeds TSHS. 575,000/= 305,000+3.5% in excess of

TSHS 16,000,000 but does TSHS. 16,000,000
not exceed TSHS. 20,000,000

b) Individuals who prepare audited accounts.

This is a group of taxpayers whose annual turnover is above TSHS 20,000,000 and are
required to prepare audited accounts/financial statements in respect of their business.
Taxpayers under this group are taxed basing on their profits.

Filing of tax returns and payment of tax.

The statement of estimated tax payable.

The statement of estimated tax payable is a provisional return which a taxpayer is required
to complete and file to the Commissioner within three months from the beginning of the
year of income (which for individuals shall be calendar year).

The taxpayer is supposed to pay the estimated tax in a maximum of four installments each
falling due after three months. The Due dates are as follows:

 On or before 31st March

 On or before 30th June
  On or before 30th September

 On or before 31st December

Form: ITX200.01.E – Statement of Estimated assessment - Individual

Filing of Final returns.

 A taxpayer must file a final tax return to TRA within six months after the end of
each tax year. The taxpayer must file return in the period between 1 st January and
30th June

Forms: ITX201.01.E Return of Income – Individual

Late payment of tax.

Late payment and filing shall be charged interest at the prevailing statutory rate at the time
of imposition plus 5% per annum